Obsession

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Obsession

US-benchmark oil prices are at a 15-month high today, gasoline and diesel prices are rising with them, and the usual suspects seem to blame—escalating geopolitical trouble (this time in Egypt) and tight supplies (lower US stockpiles.)

But the usual explanations don’t quite work. Instead, we seem to be watching the handiwork of conflicted traders who, while healthily wringing out a longstanding distortion in the market, are also exhibiting primordial casino behavior (more on this below.)

The Suez Canal is not likely to close, but let’s say it does

First, consider the worst-case scenario from Egypt: a possible closure of the Suez Canal and the 200-mile-long trans-Egyptian Suez-Mediterranean pipeline, through which a combined two million barrels a day of crude oil moves to the market.

Tanker traffic and oil continue to flow unimpeded through both the canal and the pipeline, which the Egyptian military has reason to ensure continues since they earn the government about $5 billion a year in tariffs and fees. But in the improbable event that they are forced to close, they would strip out just 2% of the daily global oil supply of about 89 million barrels a day. That’s a bit more than the daily volume of Iranian crude that international sanctions have removed from the market without an impact on prices.

As for tight supplies, the US Energy Information Administration reported today that crude oil stockpiles plunged by 9.9 million barrels last week. That is true for the week. But it still leaves US inventories at their highest level (paywall) in two decades. Meanwhile, US oil production continues to surge.

Finally, let’s look at the bigger picture. The largest source of new oil demand on the planet—China—today reported a decline in crude oil imports for the first half of the year. Another sign of the country’s soft economy, it is the first six-month oil-import contraction in China since the depths of the 2009 global financial crisis. It worries economists because oil demand is a proxy for Chinese GDP growth, and a leading indicator of the direction of the global economy.

Combining all these factors—moderate global risk, high inventories and a solid supply—you do not see the ideal conditions for surging oil prices. Yet, US-benchmark crude, known as West Texas Intermediate (WTI), pushed past $106 a barrel today, up 11.6% from June 20. US motorists are paying more for gasoline and diesel.

But those have been insufficient reasons to leave the Casino

If the fundamentals are not responsible for the price rise, what is? One thing happening is that traders are pushing the two main benchmark oil prices back together after years of playing a sometimes yawning discrepancy between them.

WTI prices are climbing toward the global benchmark, known as Brent, which was about $108 a barrel today. The two benchmarks are now separated by less than $3 a barrel, their narrowest gap since Dec. 3, 2010, when it was $1.85 a barrel (you can find historical prices here.) By comparison, the gap reached as high as $29.59 a barrel, on Sept. 23, 2011.

But as recently as the first half of 2010, WTI regularly cost just a bit more than Brent. The reason that the benchmarks flipped, and the discrepancy widened so much, is that US pipelines failed to keep up with changes in the country’s supply situation—crude was pouring in from Canada and from US shale oil fields, which overwhelmed the WTI terminus in Cushing, Oklahoma; there simply was not sufficient pipeline space to quickly get the surplus crude from there to refineries.

With the WTI bottled up in Cushing, traders were able to bid down its price, and hence create the gap with easy-to-ship Brent. But in recent months, builders finished long-anticipated pipelines, relieving Cushing. A lot of oil still gets railed, but the pipeline bottlenecks are largely gone.

As a result, “WTI is re-establishing its dominance as the go-to global benchmark,” Phil Flynn, an analyst with the Price Futures Group, told Quartz.

The final reason for higher prices is that traders–having a mind and rationale entirely their own–have simply been very, very active in recent days. Flynn thinks they have pushed prices too high. Regardless of the natural realignment of WTI and Brent, the market fundamentals—global supply and demand—call for lower prices. “The bulls have gripped control as the market has gone out of control,” Flynn said in a report. Traders were not listening. But their bet is getting riskier.